The disappointing economic growth rate in Australia is taking its toll and the Reserve Bank of Australia may be forced to lower interest rates to below zero sometime soon.
Last week, the RBA dropped its cash target to 1.75 percent after government data showed consumer prices declined during the first quarter. But underlying weakness in the jobs market and decreased consumer demand may prompt policy makers to resort to several more cuts before the year is out.
Consumer price inflation slid 0.2 percent during the January-March quarter, the worst quarterly drop since 2008, and the RBA is now forecasting a drop in the economy’s underlying inflation rate for 2016 from its previous estimate of 2-3 per cent to just between 1-2 percent.
The Aussie fell for a third straight day Tuesday-- 0.2 percent to 73.04 cents --after commodity prices plunged the day before and a report over the weekend showed imports fell in China, Australia’s biggest trading partner for the 18th month. The currency slid more than 3 percent last week, its steepest loss in four months.
The RBA rate cuts have been powering Aussie bonds and local sovereign securities surged 2 percent in the week to May 9. The 10-year yield slid to within a basis point of a record low on Tuesday and 20-year bond yields were just 2.93 percent, 2.96 percent less than the three-year notes issued ahead of Australia’s last federal election in 2013.
Struggling Economy
Australia’s economy has been struggling for quite awhile with a slump in commodity prices and a breakdown in mining investment. It may now be forced to follow the global trend driven by central banks in Europe and Japan to adopt negative interest rates.
Economic forecasters are predicting that the central bank will shave another quarter point off its key rate by August and keep the benchmark at 1.5 percent until the middle of 2017. Other forecasts see an additional reduction in November.
Sydney-based, BT Investment Management (BTIM) and other fund managers, point to Sydney’s recent gross domestic product (GDP) data as evidence that the country’s economic growth shows a "lack of sustainability," resulting from a slowdown in apartment building and a drop in Chinese steel production. Consumer expenditures have decreased due to high personal debt levels and there is little likelihood the government will step in with any spending incentives.
Other central banks such as the European Central Bank, the Bank of Japan (BOJ) and the Riksbank in Sweden, have all introduced negative rates during periods of unenthusiastic consumer price growth hoping to revive their countries’ economies. The efficacy of this move has not been proven as yet and strategists warn of the dangers involved in doing so pointing to the increased risk of consumers storing their money at home instead of spending it which could lead to even worse inflation.
Another concern is the unpredictability of the effects of negative rates and strategists use recent BOJ rate reductions as an example of what could go wrong. Japan’s central bank introduced negative rates at the end of January, in a move that should have brought about the depreciation of the yen. Instead, the currency continues to rally months after the decision.